The Economics of Renewable Energy - Economic Affairs Committee - Contents


Examination of Witnesses (Questions 248 - 259)

TUESDAY 17 JUNE 2008

Professor Gordon MacKerron

  Q248  Chairman: Welcome, Professor MacKerron. Thank you for coming to give evidence to us. What do you consider to be the key considerations for UK energy policy (that is energy and not just electricity)? How do you see renewables fitting into that policy?

  Professor MacKerron: That is a big question; I will endeavour to be fairly brief on it at least to start with. I would have thought the most important single difficulty facing energy policy is the potential trade-off between different objectives. Clearly the two major objectives now are energy security on the one hand (which seems particularly powerful as an objective at the moment) and the long term climate change objectives (which, as you know, the Government has espoused since at least 2003). I think the difficulty is that policies designed to counteract climate change are nearly always good for security, but policies that are designed to be good for security are not always good for climate change. Specifically a policy for security that emphasises the use of coal is going to counteract objectives for climate change in the absence, as we have already heard, of any realistic prospect for carbon capture and storage in my opinion probably for 15 or 20 years and that is if things go reasonably well. Perhaps in a slightly more political context, the real difficulty Government faces is the urgency which it and the European Union perceive in proceeding towards rapid carbon emission cuts and acquiring enough political legitimacy to do so. It may require some difficult choices which voters and consumers may find quite awkward and making policies stick while having the urgency which Government now believes is necessary I think is a big and difficult issue which Government will have to keep grappling with for some time. On the subject of renewables, renewables have a number of advantages in relation to policy objectives. In terms of the security objective they add diversity to the system and a subject to which I might return later if we have time is the portfolio effect of adding renewables to a system that is predominantly fossil fuel. They clearly substitute at some level for fossil fuels; they reduce pressure on world fossil fuel markets to the extent that security is an issue of dependence on oil and oil prices. There is help in that area too. There is of course a direct effect on climate change. You have already explored with the previous witnesses who have more expertise than I do some of the issues about intermittency of renewables which, in another dimension of security, may be thought to reduce security. My own view is that we will probably find ways of managing that relatively cheaply partly because other countries such as Denmark are already facing and, as far as I can judge, making reasonably good technical progress in solving the problems. In economic terms there are two major market failures involved in renewable energy. First of all it helps the problem of unpriced carbon which, of course, despite the European Emissions Trading Scheme, is not a good investment incentive at all, and the fact that R&D will tend to be underprovided in any private system because of its widespread availability to other parties. Whether renewables currently are well managed in relation to these objectives is a different question. I would differ slightly from the previous witnesses in thinking that there are real difficulties in terms of risk around the Renewables Obligation. In terms of value for money feed-in tariffs appear to have strong advantages. That is a subject you may wish to return to later, but those would be my opening remarks on the subject.

  Q249  Lord Layard: Looking at electricity, how do the costs of generating electricity from renewables compare in your view with fossil fuel and nuclear generation?

  Professor MacKerron: It is very easy being an academic to say that that is a very hard question to answer, but that is how I will start. The first issue is that although the stand alone costs of individual technologies do matter and of course to private companies who are going to invest their return will very much depend upon the balance of the costs and the return they will get on their investment but, to come back to the point I made earlier, it is important to look at the system impacts on investments; whether that is a nuclear investment or a renewable or a fossil fuel investment matters a great deal. A particular advantage of renewables is that because their risk profile is not correlated with the risks of fossil fuel generation—so when fossil fuels become more expensive that does not affect the generating costs of renewables or, for that matter, nuclear—the value to an energy system (an electricity system) of adding renewables which are currently a small proportion of the system and where the risks are not correlated with the fossil fuels, the value to the system is greater than reflected in the probably much higher stand alone costs. The difficulty in a privatised, liberalised system is that that advantage cannot be captured by the individual investor because it is a system property which affects consumers. That must be set against some of the drawbacks of renewables which you have heard about before which include a need for backup, which again is a cost that will not be met by the renewables investor as and when it becomes an important issue. That is important to say. What are the costs of renewables? They are very various. You have heard estimates for onshore and offshore wind. For other technologies for which we have hopes but which are not yet commercial such as tidal and wave, frankly it is really not very helpful to put numbers unless you put a very wide range around them in which case their value is of restricted use. When it comes to fossil fuels it is clear that under current conditions they are the cheapest and most commercial option, historically gas and probably coal now if that was not subject to regulatory provision. However, as we have also heard, oil and gas prices do vary very substantially. To quote a single number for what is the cost of, say, a gas fired power station built today with a lifetime perhaps of 30 years depends entirely upon unknowable figures for the future of gas prices, so it is very difficult to say. In terms of nuclear there are real difficulties in prediction there as well. We have not tried building a nuclear power station in this country for over 20 years; we do not yet know which design we might build; we do not know what regulatory provisions will adhere to that design with implications of cost. Perhaps, most importantly of all, we do not know whether or not we will build a series or a single unit. If we were to build a series we would probably have construction costs something like 30 per cent lower than if we build only one. Our history, as you probably know, is that we tend to build one at a time in the UK; that could change, but that is our history. There are finally issues about the back-end of the nuclear fuel cycle, about radioactive waste and de-commissioning which probably are not very large costs, especially if you allow a discounting over a long period into the future, but which nevertheless worry investors a great deal. I am quoted in the Financial Times saying that Government has offered now a fixed price to take waste off nuclear operators' hands which may be a necessary condition for nuclear investment but is, in my view, a subsidy of some indeterminate kind. I do not necessarily object to subsidies but I think it is important to recognise that it is a subsidy rather than something that the market has provided. That is my somewhat qualified answer, but I just do not think it is worth pretending that we know things about the future that we do not; that is a major difficulty for Government and for private investors.

  Q250  Lord Macdonald of Tradeston: Just picking up on your quote in the Financial Times on the hidden subsidies, as you saw it, for new nuclear plants in the form of fixed price for waste disposal. Do you think that the Government should support nuclear power in a similar way to renewables? If so, the waste disposal that you talk about, is that where subsidy might best be focussed? How would subsidising nuclear affect the economics of renewable generation overall?

  Professor MacKerron: There is clearly a case for subsidy of nuclear on the grounds that it is a low carbon option and because carbon is not adequately priced there is a case for helping nuclear power on those grounds similarly to renewables. On the other hand I would have thought the subsidy that nuclear, as it were, deserves in this kind of analysis is somewhat less because nuclear has a long history of research and development support. There is a very large and increasingly now flourishing international industry in nuclear power and in those circumstances I think the subsidy probably should not be so great because renewables I think have greater and longer term prospects because their research and development has historically been so limited. In terms of how a subsidy might be given, it does seem to me that waste is a very likely area because that is what investors seem to worry about most, even if the discounted costs of waste so far ahead are relatively low. It does seem to me that the back-end of the nuclear fuel cycle—that is the decommissioning and waste—is a responsibility which always in the end devolves to governments partly because of the extreme hazard that might be represented by the worst possible outcome but also because of the very long time horizons. On current estimates we would not start to dispose underground of waste from new build for about 100 years. That is because of the time it will take us to build a repository and the fact that our legacy waste is inevitably ahead of new build waste in the queue to be disposed; one would not want to re-package it at very high cost. We are talking about timescales of 100 to 150 years which we do not really have any mechanisms for private firms to handle. In the end I think it has to be a government responsibility and that may be seen as a drawback of nuclear power but I think it is an inevitable consequence of support for it. Finally on the subsidy issue, clearly what investors in nuclear power also desperately want is some guarantee of the selling price they will get for their product which will be something like 10 to 30 years ahead. Of course present market conditions do not provide that and although the carbon price may be positive and large in ten to 30 years' time no private investor will bet on it right now. I think these are questions that are still somewhat open and Government's reluctance to admit to subsidy I think is because if they did they would be sent off to Brussels under state aids and we do not know quite how long it would take before they would come back out of Brussels on that score.

  Q251  Lord Paul: How significant, in your view, is the potential for reducing carbon emissions by placing greater emphasis on the development of carbon capture and storage? How cost-effective, compared with the alternatives, is carbon capture and storage? Should the government be more pro-active in supporting its development?

  Professor MacKerron: I will try to be brief; my answers are not terribly different from those you have already heard this afternoon. It is clearly going to take a long time. I have recently been speaking to people who represent the Government of India at a bureaucratic level who tell me that for India there is no serious policy interest of any kind at all. It is a matter of probably 20 years before it gets fully onto the policy agenda. Of course that could be sooner, but that is their current estimate. From a domestic perspective, carbon capture and storage is probably more helpful in relation to gas than to coal because it will be cheaper and gas still emits carbon dioxide. Because of the international perspective, especially in relation to India and China, coal is inevitably the main focus. The major difficulty about predicting the cost is that the cost will vary enormously depending upon the storage location and the distance from the point at which the carbon is captured and the point where it will finally be stored. If it is in a relatively nearby offshore oil well and there is the possibility of enhanced oil recovery, that part of the cost equation will be very low. If, on the other hand, one has to find a deep saline aquifer and characterise it and it is perhaps a couple of hundred miles from where the capture takes place, the costs are frankly yet unknown but probably very high. It will be an expensive technology, there is no question about that. On present technologies you pay a significant penalty in reducing the power output because of the power you need to run the capture plant. That is a major objection that, for example, the Indian Government currently has, that it will lose a great deal of the power that it badly wants for its development effort and capturing the carbon is of rather less interest to the Indian Government for quite legitimate reasons at present.

  Q252  Lord Griffths of Fforestfach: How long do you think it is going to take before we see this practically implemented in the UK?

  Professor MacKerron: I would have thought 2020 would be very optimistic. We have yet to demonstrate it fully on a commercial scale and there are questions about whether pre-combustion or post-combustion is the right route to go down. The Government is going for post-combustion probably because it thinks the long term export prospects to India and China might be better served that way. It is not clear to me that that would necessarily prove to be economically the most viable or best way forward. I heard on the radio the other day the Energy Minister saying that in the current comprehensive spending review there is no money for government support for the carbon capture and storage project to move onto the competitive process. I have heard industry people saying perhaps 2025 as a more or less hoped-for estimate of when commercial application at scale might be possible. These things are of course speculative.

  Q253  Chairman: Let me put the question in a slightly different way and that is that if Government decided to put its shoulder to that wheel and put the resource in, how soon could it be done?

  Professor MacKerron: I think you could then talk about 2020 as being a more realistic timeframe but there are still significant technical uncertainties. It could go very slightly better than that, but even with shoulder to the wheel it might go worse than that as well. One might say 2020 would be a reasonably optimistic timeframe.

  Q254  Lord Moonie: Do the UK's electricity trading and transmission arrangements provide a suitable framework for an industry with a high proportion of renewable electricity generation?

  Professor MacKerron: I think the answer broadly speaking is no but that does not mean that there is no hope. On the subject of transmission and particularly the distribution in local systems they were of course designed for large centralised remote power stations, simply stepping the power down from very high voltage down to factories, households and so on. There is already a big and technically quite complex effort to try to change the transportation system for electricity to allow for a much more interactive system which can accept much smaller and more local generation which I think most of us think is going to be one important ingredient of any future which is more low carbon. There are real transmission difficulties which you have heard about already today in renewables because of course renewables have to be sited where they have to be sited not necessarily near centres of demand and that is an issue that takes some time to resolve. I think it is possible that we can change our transmission and distribution arrangements in time for the expansion that we expect in renewable energy, but the one area which I think is badly neglected and does need more attention is in the area of very small scale renewable generation. There is real prospect in the long term for micro-generation at household and block of flats level which is, among other barriers, seriously inhibited by the fact that we do not have any arrangements for trading or physical distribution—reversing the flow—to give an incentive to owners of small commercial premises, householders or blocks of flats to engage in renewable and other forms of micro-generation. That is an area I think that is seriously neglected and in which Government has been extremely slow to take action despite a number of reviews.

  Q255  Lord Best: You said blocks of flats and commercial buildings and one is perhaps looking at quite big blocks of flats—tower blocks—and big commercial buildings. Would you agree that efforts to micro-generate at the level of the individual household are likely to be waste of everybody's time, unless you live in the Scottish Highlands?

  Professor MacKerron: Micro wind at household level in urban areas is, I think, a dead duck; there is no obvious future in it without any major technological change. Some types of micro-generation do not work at that scale. The kind of micro-generation more likely to work at that scale would probably involve the use of fossil fuels but probably at very high levels of efficiency, so very small scale combined heat and power is potentially quite an attractive prospect and that will save a lot of carbon emissions compared to using mains gas or central heating. I know it is not the subject of your inquiry but in the area of micro-generation that is much more promising than micro-wind which frankly has not got much future at all for the great majority of householders in a country like the UK.

  Q256  Lord Griffths of Fforestfach: Do you think it is important that we have in the UK a broad range of technologies providing electricity and do you think the benefits can be quantified?

  Professor MacKerron: I think it is important to have a reasonable range. It is difficult to say how many; one cannot come to very deterministic answers. I think to return to a point I made earlier, there are some techniques, mostly borrowed from orthodox finance theory—mean-variance portfolio analysis—which do suggest that where a technology has a small share and its risks are uncorrelated with those of the dominant technology, the value to the system as in standard portfolio analysis is actually somewhat greater than the standalone cost. My late colleague Shimon Awerbuch from the University of Sussex did very good work on precisely trying to quantify the different standalone costs, what the system advantage might be of introducing renewables and there are other techniques being developed around valuation, diversity, trading it off against performance in the form of standalone costs which I would be happy to share literature with you on if that is of interest. There are ways of doing the quantification. The more difficult issue is how to reward the existing rather fragmented market system for system benefits which at the moment cannot be captured by individual investors. That is one of the reasons why I personally think that the Government needs to intervene somewhat more than it currently does in order to try to find ways of rewarding genuine benefits for systems—which could apply to nuclear technology as well as renewables—where those effects take place.

  Q257  Lord Best: In terms of that Government intervention, you are saying more of it is necessary. You would not say that the Government has been very effective so far in its policies in terms of more renewable energy. What have been the most cost-effective forms of support in your view in the UK and in other countries? What should be the balance between subsidies, guaranteed prices, quotas, carbon taxes and other forms of support?

  Professor MacKerron: I think one has to confine one's attention to those instruments that seem politically plausible. Within Europe I think carbon taxes on any significant scale are not currently plausible and emissions trading is the fashionable way. I do not say "fashionable" to decry it but nevertheless, politically speaking, it is the way we are going. In terms of specific renewables instruments the research with which I am familiar does quite strongly suggest that well-designed feed-in tariffs, where you differentiate the guaranteed price you will give for individual technologies, not only elicit renewables more rapidly but they do elicit them at a lower cost to the consumer. There is good, reputable published research comparing, for example, Germany and the UK, which will show that value for money is substantially greater in the German system. Having said that, I think that the Government has a real dilemma. Having gone for a renewables obligation it is very sensitive to the criticism that comes from investors, that investors want some kind of certainty in the public policy system; they do not want Government to keep changing horses every five years. I think there are ways around that. You can ring-fence those people who have already invested in the renewables obligation system; it is a little bit messy but it could be done, and I would not like us to be trapped forever in the renewables obligations systems when I think increasingly the evidence is that a feed-in tariff would be more effective. However, I recognise that the transitional problems are quite substantial and Government has some difficulty with that.

  Q258  Lord Lawson of Blaby: This is all really totally unreal, is it not? You very correctly pointed out that the Indians have no interest at the present time and for the foreseeable future in making their energy more expensive by carbon capture and storage. That is really part of a general pattern. It is certainly the case of China and India and a number of less important countries; their priorities are the cheapest possible energy. That does not mean to say that they will reduce their energy intensity through improvements in efficiency, but they are going to keep on using carbon and producing energy and therefore the whole thing is pie in the sky. All the money we are spending is only to reduce global emissions, and global emissions are not going to be reduced by this massive amount we are told is necessary. Whether it is or not is another matter, we will not go into that. All we can try and do is do this charade at the least cost and that is really my question to you. If we are going to say that we want to have a renewables policy, have a significant part of our energy produced by renewables, the Government has gone very heavily into wind power and, although it is not a renewable thing, they are going in a slightly less enthusiastic way into nuclear. How that is going to work out we shall see. With your great knowledge of these various different forms of electricity generation what is in your opinion the best buy of the various renewables and by how much is it the best value? Or are they all much of a muchness? You may include nuclear in your answer.

  Professor MacKerron: Let me start by saying something that is a repetition of what you heard before but I still hold that it is genuine. Renewables do bring other benefits than simply reduced carbon emissions. In a world that is increasingly worried about energy security renewables can be quite helpful as both a more diverse source and a source that reduces our dependence on fossil fuels. There are countries—but we are not among them—that have acquired industrial policy benefits from renewables but I am afraid the way Government has organised its policy in that area in our country that is not the case. Coming now to the substance of your question, what is the sort of Which? report best buy on this subject, I think there is no doubt that because of the way the Renewables Obligation has worked it has sought out and concentrated on that technology which currently has been the best buy and that is onshore wind. Offshore wind, I believe, can become not quite as cost effective as onshore but will become, I think, substantially cheaper. I think we need, in cooperation with other countries—I stress that very much—to have much more intensive research and development efforts into other credible renewable energy technologies, among which the marine technologies (in which, as you know, Scotland has a particularly strong interest) do have major long term prospects, not least because some of them do not have some of the intermittency characteristics that wind does (in particular tidal is a possibility). Biofuels are of course a major issue at the moment. I think there is a certain hysteria about biofuels which suggest that they are in almost all circumstances terrible. I do not think we have the research base to say that, but clearly people are right to point to some of the conflicts between food and fuel for land use and they are unavoidable. If you want to come to nuclear, I think we are still in a position of enormous uncertainty about nuclear. If we repeat our past policy on nuclear which is to build the odd reactor here and there to a different design, frankly I think they will turn out to be very expensive. On the other hand, if we were to go for a very large programme with Government support we would seriously run the risk of undermining the market that we so painstakingly built up over the last few years. There are some difficult trade-offs there and frankly I do not think we know in the case of nuclear where we are. The short answer is that what we have been doing is the best option to date.

  Q259  Lord Lawson of Blaby: Let me put the question another way, but maybe the answer is the same. Supposing the Government were to come in and say "We are prepared to provide a subsidy of whatever it is per gigawatt of electricity generating and we are committed to maintaining that for a reasonable period of time" and leave it to the market—the industry—to decide which of these various sources of energy or electricity they would be most likely to find investors to support, would they all go for wind power do you think, or not, looking across the world and not just from our own experience?

  Professor MacKerron: The UK would certainly go for wind for now because there is a reasonably well-established cost base for wind. You heard the previous remark that the costs of the raw materials for wind such as copper and steel have inflated in recent years which has made wind, at least temporarily, as well as nuclear substantially more expensive than we expected. Nevertheless, there is a kind of certainty about wind which would give investors some comfort. I am sure they would then wish to explore whether or not nuclear would give them the same degree of comfort and it is possible that over time—it would not be immediately—they might decide that nuclear was a good bet. If you look at other countries you get a different picture. If you went to France you would almost certainly discover that nuclear seemed the best bet, not especially because of the market but because the French state has built up a huge protective subsidy implicit and explicit around its nuclear enterprise which has been run quite efficiently for a long time. There would be large national differences and of course we have one of the more liberalised markets in the world; others would not have quite that kind of open market competition, the sort that is imaginable in the UK but probably would not happen to the same extent elsewhere. I suspect my answer has not been terribly different from the other way round when you first asked me it.


 
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